Oxford Business Law Blog bloghttps://www.law.ox.ac.uk/business-law-blog/blog/16118
enIgnorance, Debt and Cryptocurrencies: The old and the new in the law and economics of concurrent currencieshttps://www.law.ox.ac.uk/business-law-blog/blog/2018/03/ignorance-debt-and-cryptocurrencies-old-and-new-law-and-economics
Decentralized, permissionless and blockchain-based cryptocurrencies and their underlying technology are said to have as transformative an impact on value as the invention of the internet had on information. For decades, the double-spending problem was the main roadblock to the emergence of cryptocurrencies. The Bitcoin Blockchain eventually solved this problem in a highly secure, decentralized, consensus-based, and censorship-resistant manner without relyingMon, 19 Mar 2018 05:30:00 +0000Hossein Nabilou, André Prüm18353 at https://www.law.ox.ac.ukDecentralized, permissionless and blockchain-based cryptocurrencies and their underlying technology are said to have as transformative an impact on value as the invention of the internet had on information. For decades, the double-spending problem was the main roadblock to the emergence of cryptocurrencies. The Bitcoin Blockchain eventually solved this problem in a highly secure, decentralized, consensus-based, and censorship-resistant manner without relying on third parties. This has harbingered the advent of a whole variety of different cryptocurrencies, with varying degrees of societal risk-reward payoffs. Although regulators on both sides of the Atlantic have taken a passive approach to regulating cryptocurrencies, with the increasing popularity and potential success of cryptocurrency experiments, it is likely that governments will take interest and involve in regulating them in the foreseeable future.

In our recent paper titled 'ignorance, debt and cryptocurrencies', building on the seminal work of Holmstrom (2015), we analyse how information economics of Bitcoin, which is built on symmetric (common) knowledge, trumps that of central bank money, commercial bank money and shadow bank money, which is built on symmetric ignorance as to the underlying collateral. We argue that this informational distinction can potentially make Bitcoin a new 'safe' asset, holding the promise of maturing into a viable store of value, a potential medium of exchange, and a unit of account. By comparing the information economics of central, commercial and shadow bank money with that of Bitcoin, we highlight important aspects of information economics of Bitcoin that can inform any pending regulatory intervention in the cryptocurrency ecosystem.

In fiat currency context, A is willing to accept a piece of paper as a method of payment in anticipation of B willing to accept it from A, and C willing to accept it from A and B, ad infinitum. For this to happen, the settlement asset should not give rise to any adverse selection problem arising from the information asymmetry as to the value of the settlement asset. In transactional terms, the more adverse-selection proof an asset, the better it is for transactional purposes (medium of exchange). To be adverse-selection proof, the asset should be information-insensitive and its information insensitivity should be common knowledge.

Fiat money, including commercial and shadow bank money, is legally constructed as a debt contract. Finance literature suggests that debt instruments have traditionally been superior to equity instruments in addressing informational problems between the borrowers (issuers) and lenders (shareholders). Debt-on-debt (debt used as collateral for another debt contract) minimizes financial market participants' incentives to produce private information about the ultimate payoffs (Dang, Gorton, Holmstrom, 2012). This makes debt the least information-sensitive instrument in financial markets. This near-information insensitivity removes adverse selection problems, contributes to the liquidity of debt instruments, helps public adoption and thereby makes them a viable instrument for both market and funding liquidity.

However, no debt instrument, including central bank money, is entirely free from adverse selection problems. There are different methods to mitigate adverse selection. Signalling and screening have traditionally been the two well-known mechanisms to mitigate information asymmetry; the root cause of adverse selection. Another way to address the adverse selection problem is to basically do away with information asymmetry by either shedding sunlight on the settlement asset so that its value would be symmetrically evaluated by both parties to a transaction (common knowledge), or by obscuring and hiding all information so that neither party to a transaction would be able to or would have an incentive to acquire information about the underlying collateral of the debt instrument (symmetric ignorance).

Since an ultimate means of payment and settlement needs to be the most information insensitive and completely free from adverse selection problems, we argue that for such an asset (money) neither signalling nor screening mechanisms provide complete information insensitivity. Instead, for such an asset to best perform its function as an ultimate means of settlement, its value and underlying mechanisms should be either common knowledge or should not be known to any financial market participant at all (symmetric ignorance). It is no surprise that governments have chosen the latter path. The residual information insensitivity of central bank money (arguably the safest asset in a given market) has been eliminated by making all financial market participants 'symmetrically ignorant' of the value of the underlying collateral (a vague promise based on the full faith and credit of the government). This symmetric ignorance of all market participants as to the value and nature of that collateral removes all incentives for participants to acquire any information about the underlying collateral (hence a state of blissful symmetric ignorance).

Commercial bank and shadow bank money use different techniques to create money, but ultimately, all those techniques explicitly or implicitly fall back on the government safety net (government credit and liquidity puts). The main techniques used to create information insensitive assets in the banking and shadow banking system are insurance, (over)collateralization, imposing prudential requirements on issuing entities, and granting preferential regulatory treatment to quasi-money instruments (bankruptcy safe harbours for repos). In all these cases, the value of a safety-enhancing external element (eg, collateral in repos, government credit and liquidity puts in deposits) removes the depositors' or investors' incentives to acquire information about the underlying debt contract, making it information insensitive.

The information economics and potential information insensitivity of Bitcoin, however, stands at stark contrast to that of fiat money, as Bitcoin relies on the common (symmetric) knowledge as to the underlying inner workings of the Bitcoin Blockchain. The proposition that ignorance can be turned into knowledge, but knowledge cannot be reversed back into ignorance, is central to the information insensitivity of Bitcoin. Full transparency in the Bitcoin Blockchain eliminates incentives to acquire new information, thereby eliminating the adverse selection problem as to the value of Bitcoin as a medium of exchange. This superior informational feature of Bitcoin can potentially transform it into a potential safe asset, a good store of value, a medium of exchange, and a unit of account.

Given the superior quality of Bitcoin as compared to fiat money and the absence of market failures in Bitcoin in terms of information economics, regulatory intervention would not be warranted. More importantly, since the cryptocurrency industry in general is in its infancy, a hard-touch regulatory approach can hinder the potential welfare-enhancing innovations coming from this ecosystem. However, this suggestion should not be mistaken for an advocacy of regulatory faineance, as the ecosystem suffers from legal uncertainty. To the contrary, this approach is a defence of regulatory sobriety, data dependency, and a deference to the virtues of experimentation, permissionless innovation, the spontaneous discovery process and evolutionary dynamics in the financial system. This being said, the fast and ever-changing cryptocurrency ecosystem should put regulators on alert as market failures and potential for abuse will likely develop swiftly.

Hossein Nabilou is a postdoctoral researcher in Banking and Financial Law at the University of Luxembourg; Faculty of Law, Economics and Finance and André Prüm is a Professor of law, Chair in Banking, Financial and Business Law at the University of Luxembourg; Faculty of Law, Economics and Finance.

]]>Is EU Merger Control Used for Protectionism? An Empirical Analysishttps://www.law.ox.ac.uk/business-law-blog/blog/2018/03/eu-merger-control-used-protectionism-empirical-analysis
The European Commission’s merger-review power has been a subject of controversy among lawmakers and commentators for more than two decades. One reason for this is that the Commission has sometimes used its extensive competition authority to prohibit high-profile mergers involving non-EU firms—even where those same acquisitions are approved by other competition authorities. The Commission’s 2001 decision to block the $42Fri, 16 Mar 2018 05:30:00 +0000Anu Bradford, Jonathon Zytnick18350 at https://www.law.ox.ac.ukThe European Commission’s merger-review power has been a subject of controversy among lawmakers and commentators for more than two decades. One reason for this is that the Commission has sometimes used its extensive competition authority to prohibit high-profile mergers involving non-EU firms—even where those same acquisitions are approved by other competition authorities. The Commission’s 2001 decision to block the $42 billion acquisition of Honeywell by General Electric—a merger approved by the US Department of Justice—is perhaps the most well-known of these cases, an anecdote that looms large in competition-law lore. But GE/Honeywell does not stand alone. In the name of competition law, the Commission has repeatedly blocked or forced significant restructuring of mergers involving a wide range of well-known American firms, including Boeing, MCI WorldCom, Time Warner and UPS.

These high-profile interventions have raised concerns that the Commission is using its merger-review power to advance protectionist industrial policy rather than competition. In the wake of GE/Honeywell itself, for example, US Treasury Secretary Paul O’Neill called the Commission’s decision ‘off the wall’, describing the Commission as ‘autocratic’, and the Department of Justice’s chief antitrust enforcement official noted the Commission’s ‘divergence’ from the principle that ‘the antitrust laws protect competition, not competitors’. Members of the US Congress expressly accused the Commission of ‘using its merger-review process as a tool to protect and promote European industry at the expense of US competitors’. Today, the primary concern is the Commission’s mounting antitrust and State aid investigations of US high-tech companies, including Google, Qualcomm, and Apple, which critics say reflect the EU’s attempt to offset US technological edge and tilt the market in favor of their weaker European rivals.

The notion that the Commission’s merger-review authority is used to protect European firms from foreign competition should not be taken lightly. For one thing, the economic stakes are high: in Europe alone, the value of mergers and acquisitions in 2014 was about $900 billion. For another, the increasingly international focus of merger activity makes clear that only rarely—if ever—will a significant merger escape the Commission’s antitrust mandate. Yet the idea that a critical gatekeeper for global merger activity is using its authority to protect favored firms rests largely on a few famous anecdotes. The Commission’s decision-making has not been subjected to the kind of systematic empirical analysis that could rigorously test those intuitions.

In our article, we introduce a unique dataset that permits us to provide the first careful examination of the determinants of the Commission’s merger review policy. While previous analysis of the Commission’s decisions has relied on small, hand-drawn samples ranging from 96 to 245 cases, our novel data offer the unique opportunity to examine the Commission’s enforcement record across more than 25 years and over 5,000 cases.

We identify evidence that, contrary to policymakers’ and practitioners’ intuitions, the Commission has not intervened more frequently, or more extensively, in transactions involving a non-EU- or American-based firm’s acquisition of a European target. If anything, our results suggests that the Commission is less likely to challenge transactions involving non-EU acquirers. Of course, it may well be that protectionism plays an occasional role in European merger-review cases. We show, however, that the evidence does not support the claim that any such bias systematically affects merger-enforcement outcomes in the European Commission. Our finding challenges the conventional wisdom that portrays the European Commission as a protectionist institution that deploys its vast merger control powers as a tool for industrial policy.

Anu Bradford is the Henry L. Moses Professor of Law and International Organization at Columbia University.

]]>Reflections on the Volkswagen Emissions Scandalhttps://www.law.ox.ac.uk/business-law-blog/blog/2018/03/reflections-volkswagen-emissions-scandal
The Volkswagen diesel emissions scandal is in the first instance a case of market failure, because the harm from vehicle emissions to public health and to the environment is neither internalized by car producers nor by car drivers. This market failure is neither corrected by public regulation nor by civil liability. There is regulatory failure because the control of nitrogenThu, 15 Mar 2018 11:00:00 +0000Thomas Eger, Hans-Bernd Schäfer18377 at https://www.law.ox.ac.ukThe Volkswagen diesel emissions scandal is in the first instance a case of market failure, because the harm from vehicle emissions to public health and to the environment is neither internalized by car producers nor by car drivers. This market failure is neither corrected by public regulation nor by civil liability. There is regulatory failure because the control of nitrogen oxide (NOx) emissions by the German automobile regulatory agency (Kraftfahrt-bundesamt) was lenient. There is also corporate governance failure within Volkswagen through the fraud of installing manipulative software. And there is dysfunctional law, which, as a result of industrial lobbying, does not allow for class actions or similar types of lawsuits.

It seems that the civil courts kept their full independence in this matter. Courts of lower instance in their large majority decided that owners should get their money back. However so far less than 50,000 out of 2.4 million car owners have taken action against Volkswagen or Volkswagen car dealers. The others shy away from risky litigation. The procedures take much time. It is unlikely that the German Supreme Court (Bundesgerichtshof) will take a decision before the end of 2018. After that date, all limitation periods will expire. The strong signal of a Supreme Court decision, which would end legal uncertainty, will most probably only be given after the end of the limitation period. For Volkswagen, the likely consequence is that it will have to pay some hundred million Euros as compared with more than 14 billion Euros if all affected car owners would have made their claim before the end of the limitation period.

Since the 1990s, European legislators have supported modern, turbocharged direct injection diesel engines by applying laxer standards for NOx emissions and particulate matter as compared to gasoline cars. Miravete et al. (2017) estimate that this special treatment for diesel vehicles in Europe, combined with preferential fuel taxes for diesel, corresponds to an implicit import tariff of two to three times the official rate with respect to non-diesel car exporters, such as the USA and Japan. This policy was well perceived by European car producers with their comparatively large share of diesel cars and made it easier for politicians to comply with European CO2 emission standards.

In the US, where politicians have little interest in supporting diesel cars, a very different position was taken. On the one hand, reduction of CO2 emissions has never been the highest priority in the USA, probably because the relevant stakeholders have been afraid of losing competitiveness with respect to emerging market economies like China and India. On the other hand, for many decades, politicians have been facing strong pressure from large parts of the urban population suffering from ambient air pollution. Thus, it is no wonder that US car manufacturers are not familiar with modern diesel technology, and the share of diesel passenger cars remains low, NOx emission standards are high and law enforcement stricter.

The interest of car manufacturers carries enormous weight in German politics and must be balanced through permanent and increasing pressure by the victims of emission standard infringements. The (inefficient) bias in favour of car producers’ interests could be mitigated by shifting the competence for type approval from the Federal Ministry of Transport, which is tightly connected to the car industry, to the Federal Ministry for the Environment, which arguably has a stronger commitment to protecting air quality. Moreover, the removal of legal obstacles to coordinated court actions by affected car owners would improve their chance to enforce their interests via civil liability actions.

Thomas Eger is a Professor of Law and Economics at the University of Hamburg – Institute of Law and Economics and a guest contributor to the Oxford Business Law Blog.

Hans-Bernd Schäfer is a Professor of Law and Economics at the Bucerius Law School and the University of Hamburg, and a guest contributor to the Oxford Business Law Blog.

]]>The Mandatory Bid Rule – Unnecessary, Unjustifiable and Inefficienthttps://www.law.ox.ac.uk/business-law-blog/blog/2018/03/mandatory-bid-rule-unnecessary-unjustifiable-and-inefficient
The Mandatory Bid Rule (MBR) forms an important part of the EU Directive (2004/25) on Takeover Bids. The MBR is generally seen as a benign protection of investors in listed companies. The Directive itself, on the other hand, is widely seen as unsuccessful. This was probably because it went well beyond its purpose of settling the formalities surrounding cross-border takeoverThu, 15 Mar 2018 05:30:00 +0000Jesper Hansen18379 at https://www.law.ox.ac.ukThe Mandatory Bid Rule (MBR) forms an important part of the EU Directive (2004/25) on Takeover Bids. The MBR is generally seen as a benign protection of investors in listed companies. The Directive itself, on the other hand, is widely seen as unsuccessful. This was probably because it went well beyond its purpose of settling the formalities surrounding cross-border takeover bids, e.g. publication, minimum information about the bid, duration, and choice of applicable law and competent authority. Instead, it ventured to harmonise corporate governance, which is notoriously ill-suited for harmonisation.

This paper is a lecture delivered at a conference in 2016 marking the 10th anniversary of the Directive. It lays out the many well-known arguments against the MBR. It is unnecessary, because companies could adopt such a rule in their bylaws if they really want it. It is unjust, because there is no equality among shareholders in the secondary market and shareholders don’t have a claim on any ‘control premium’, which is an elusive concept anyway. It is inefficient, because its main purpose is to protect incumbent management against shareholder control and the MBR consequently prevents the necessary monitoring and disciplining available to shareholders acting in concert. By increasing the cost of company restructuring, it reduces the instances of takeovers, which the Directive was supposed to foster, and the relative efficiency that may arise in certain cases where synergies happen to serve as private benefits does not compensate for the overall loss of efficiency and damage to shareholder control and monitoring.

The MBR is undeniably popular, however, because management likes the protection and isolation from shareholders that it offers; politicians like the reduction of takeovers that may result in lay-offs among their constituencies and many have a natural deference for anything labelled investor protection; and investors, especially institutional investors who are often holding minority stakes, like the windfall that it offers, almost like a lottery paid for by others. So, there is little chance of the MBR disappearing any time soon.

It is a sad outcome well described in public choice theory: a rule that favours small vocal groups will remain even if the detrimental effect of the rule to society overall is far greater. In a time when the EU is becoming ever more unpopular, we should take the MBR as a lesson in what the powerful instrument of EU law should not be used for.

Jesper Lau Hansen is a Professor of Law at the University of Copenhagen and an occasional contributor to the Oxford Business Law Blog.

]]>Investor-State Disputes in the EU – Some Statistical Observations https://www.law.ox.ac.uk/business-law-blog/blog/2018/03/investor-state-disputes-eu-some-statistical-observations
The International Centre for Settlement of Investment Disputes (ICSID) Secretariat has published its ICSID Caseload report with a special focus on investor-state arbitration in the EU as of 30 April 2017. The report offers an interesting overview of disputes that involve EU Member States, including the number of cases registered against each Member State, the number of cases broughtWed, 14 Mar 2018 05:30:00 +0000Norton Rose Fulbright18367 at https://www.law.ox.ac.ukThe International Centre for Settlement of Investment Disputes (ICSID) Secretariat has published its ICSID Caseload report with a special focus on investor-state arbitration in the EU as of 30 April 2017. The report offers an interesting overview of disputes that involve EU Member States, including the number of cases registered against each Member State, the number of cases brought by EU investors, the type of cases registered, the basis of consent to ICSID jurisdiction, and the economic sectors involved in each instance. In this blog post, we cover a few of the key statistics from the report.

EU Member States featured prominently in Investor-State Disputes

Despite the perception that investor-state disputes tend to happen only in emerging markets, the EU in fact features fairly prominently in the report: 105 of the 608 cases registered (17%) involved a Member State party, in every instance as respondent to the claim. Spain had the highest number of recorded ICSID cases against it (28%), followed by Romania (12%) and Hungary (12%).

When comparing the ICSID Caseload report on investor-state arbitration in the EU as of March 2014, recorded cases against Member states have grown slightly from 12%. However, where there has been a dramatic spike is in cases against Spain in particular, which increased from just over 11% to 28% of total cases registered. The increase in cases against Spain is primarily due to the Spanish government withdrawing the incentives given to new investors in wind energy, solar energy and waste incineration in light of the global recession. Member States such as Spain, the Czech Republic and Italy had strongly promoted policies subsidising investments in renewable energy pursuant to the Energy Charter Treaty (ECT) objectives, but had to scale back those commitments because they could not meet the demand for subsidies after the economic crisis. In response, several groups of investors brought arbitration claims under the ECT challenging those withdrawals.

Most EU-related disputes involved the energy and extractive industries

By far, the sector most represented in claims against Member States was the Electric Power and Other Energy sector with 44% of the cases registered involving that sector. The percentage of Electric Power and Other Energy sector disputes against Member States has risen dramatically since 2014 from 24%, again in light of the new ECT claims brought against States such as Spain in response to the withdrawal of renewable energy subsidies.

Similarly, 20% of cases brought by EU investors related to this sector. As ever Oil, Gas and Mining also featured heavily for EU investors (21%), although unsurprisingly not in the EU itself (only 6% of claims against Member States related to this sector).

The majority of claims were brought under bilateral investment treaties or the Energy Charter Treaty

The vast majority of all registered cases (97%) were brought under the ICSID Convention rather than under the Additional Facility Rules. In cases brought against Member State parties, the most common grounds for establishing ICSID jurisdiction were either bilateral investment treaties (56%) or the ECT (43%). Compared to the figures in the March 2014 ICSID report, ECT disputes have risen considerably from 25%. As mentioned above, this spike is attributable to claims being brought as a result of the withdrawal of renewable energy subsidies.

However, for cases brought by EU investors, the basis of consent was predominantly bilateral investment treaties (61%), with the ECT representing a much smaller proportion (15%), followed by investment contracts (14%) and host-State investment laws (10%).

Disputes were more frequently resolved by a final award rather than a settlement

For cases against Member States, 22% were settled by the parties or discontinued before a final determination. This has decreased somewhat from the statistics represented in the March 2014 ICSID report, which showed 36% of cases settling or being discontinued. Of the remaining 78% of cases that were resolved by a final award, 47% of cases were dismissed in full, whereas 31% of cases were upheld in part or full. Jurisdiction was declined in 22% of cases.

In comparison, for those cases brought by EU investors, 35% were settled by the parties or discontinued before a final determination. Of the remaining 65% of cases that fell to be decided by a tribunal, 25% were dismissed in full, whereas 49% of investors’ claims were upheld in part or full. Jurisdiction was declined in a similar number of cases (26%).

Arbitrators from the UK and France were chosen to preside over a significant proportion of cases

In approximately 72% of appointments made in ICSID cases, the parties selected the appointees, with the remaining 28% of appointments being made by ICSID. In both scenarios, arbitrators from Member States were regularly appointed in a large proportion of investor-state disputes.

43% of all arbitral appointments in ICSID cases involved nationals from a Member State, a level that has been consistent for the last 3 years. Nationals from France and the UK continued to be the most commonly appointed, followed by Spain, Germany, Italy, Belgium and the Netherlands.

This post was written by Holly Stebbing, Partner, and Cara Dowling, Senior Knowledge Lawyer, at Norton Rose Fulbright London. With special thanks to Aimee Denholm, Knowledge Assistant, for her contribution to this blog piece.

]]>Towards Single Supervision and Resolution of Systemically Important Non-Bank Financial Institutions in the European Union https://www.law.ox.ac.uk/business-law-blog/blog/2018/03/towards-single-supervision-and-resolution-systemically-important-non
The global financial crisis proved that banks are not the sole source of systemic risk to the financial system and the wider economy. Indeed, systemic risk emanating from non-bank financial institutions proved to be a key vulnerability of the financial system. Such risks occurred, above all, when&nbsp;leveraged non-bank financial institutions performed bank-like activities such as&nbsp;maturity and/or liquidity transformation. However, theTue, 13 Mar 2018 11:00:00 +0000Danny Busch, Mirik van Rijn18366 at https://www.law.ox.ac.ukThe global financial crisis proved that banks are not the sole source of systemic risk to the financial system and the wider economy. Indeed, systemic risk emanating from non-bank financial institutions proved to be a key vulnerability of the financial system. Such risks occurred, above all, when leveraged non-bank financial institutions performed bank-like activities such as maturity and/or liquidity transformation. However, the increasingly blurred distinction between markets, financial institutions, services and products is not matched in the European Union by an integrated regulatory and supervisory approach.

Instead, regulation was and remains largely organised along sectoral lines, with an emphasis on the banking sector. As the global financial crisis shows, this creates a risk of gaps in the coverage of regulation and supervision, leading to inconsistent regulatory treatment of equivalent products and/or services. This in turn causes an unlevelled playing field and increases the potential for regulatory arbitrage. In consequence, risky activities migrate to less regulated or unregulated parts of the financial system, leading to a largely unchecked build-up of systemic risk.

Drawing inspiration from the reforms in the United States, we propose in our paper that the EU’s system of financial regulation be complemented by a robust body charged with identifying and monitoring non-bank financial institutions that are systemically important.

This EU authority should have the discretion to designate a non-bank financial institution as a Non-Bank Systemically Important Financial Institution (non-bank SIFI). A logical choice would be to confer such powers on the European Systemic Risk Board.

Designated non-bank SIFIs should be placed under direct prudential supervision by an EU body. This EU supervisor would have to establish, on an individual or categorical basis, appropriate enhanced prudential requirements tailored to the nature, risks and activities of the relevant non-bank SIFI.

Additionally, a single European resolution regime should be in place to ensure that non-bank SIFIs can fail without destabilising the financial system. This would avoid a possible ‘Too-Big-To-Fail’ status, remove implicit government guarantees and subject the institution to market discipline.

Our proposal aims to ensure that non-bank SIFIs are brought within a regulatory perimeter and supervisory scrutiny consistent with the risk they pose to financial stability. Such a regime would (i) help to eliminate (national) supervisory and regulatory gaps, (ii) reduce regulatory arbitrage activities, and (iii) contribute to the stability of the financial system and a level playing field.

DannyBuschis a Professor of Financial Law, and Mirik van Rijn is a PhD candidate in the Faculty of Law at Radboud University Nijmegen. They are both guest contributors to the Oxford Business Law Blog.

]]>Takeovers and Economic Nationalism: A Taxonomy that Protects against Abusehttps://www.law.ox.ac.uk/business-law-blog/blog/2018/03/takeovers-and-economic-nationalism-taxonomy-protects-against-abuse
The world of EU corporate governance is in turmoil. Not so long ago, the protection of a company by appealing to national legislators was considered anathema for businesses. Apprehensiveness towards Chinese investment in strategically important sectors, coupled with the fact that an open takeover regime is not reciprocally available in China, has bolstered the case for Tue, 13 Mar 2018 05:30:00 +0000Georgina Tsagas, Jeroen Veldman18344 at https://www.law.ox.ac.ukThe world of EU corporate governance is in turmoil. Not so long ago, the protection of a company by appealing to national legislators was considered anathema for businesses. Apprehensiveness towards Chinese investment in strategically important sectors, coupled with the fact that an open takeover regime is not reciprocally available in China, has bolstered the case for EU regulators and member states to increasingly scrutinize bids and draft legislation that can safely now be characterised as protectionist.

Germany became the first EU Member State to amend its rules on foreign corporate takeovers. Following, in mid July 2017, in the Netherlands, two-thirds of Dutch parliamentarians voted in favour of introducing legislation that would give protective measures to domestic companies. In January 2017, the Business, Energy and Industrial Strategy Select Committee in the UK followed through with an inquiry into the Government’s Industrial Strategy under the Government of Theresa May, considering whether foreign takeovers of UK companies should be prevented, and on what grounds. Finally, the EU summit in June 2017 saw calls being made by the French, Italian, German, Dutch, and EU lawmakers to adopt common measures to prevent unwanted takeovers, while the 28 EU leaders called on the Commission to further analyse foreign investments in sectors such as energy, banking and technology. What is one to make of this shift towards economic protectionism?

The free movement of capital constitutes one of the core elements of the functioning of the EU internal market [Hansen, 2010].[1] ‘Capital movement’, which includes any participation in a company, whether realised through ‘direct’ or ‘portfolio investment’[2] [Annex I Council Directive 88/361/EEC] is enshrined in Articles 63-66 of the Treaty on the Functioning of the EU. Article 63 specifically provides that: ‘[…] all restrictions on the movement of capital between Member States and between Member States and third countries shall be prohibited’. Governments, in principle, only have a role to play in shaping the laws in a way that provides market actors with tools that will enable them to ward off unwanted bids on legitimate grounds. Hence, in the EU, until now, providing protection either through legislation or via locking up control of a company to the State as a shareholder, was considered an unacceptable form of protectionism. Such measures, if not related to an area which constitutes a recognised exception, would be considered contrary to the free movement of capital.

A marked exception was a government’s identifying industries of public or strategic interest. Traditionally, governments wanting to protect key market players in their economy had made use of ‘golden shares’, allowing the government to either outvote the shareholders in a general meeting or to veto certain important company decision.[3] However, as the jurisprudence of the CJEU that followed made clear, the use of golden shares is prohibited under EU law. Subsequently, protectionist measures would often take the form of ‘last minute’ measures, such as finding a ‘White Knight’, ie, a company more preferable and less of a threat to the Member State’s national interests, for the company under siege [Enderwick, 2011: 331]. Notwithstanding the possibility to identify companies with a clear strategic interest for protectionist measures, under default conditions, public corporations, even if explicitly engaged with embedding a broader vision or purpose into their corporate governance structures, are not considered to be part of a particular category which enables governments to set in place protectionist measures.

In the recent AkzoNobel takeover case, however, the board played out its long-termist and stakeholder-oriented strategy as part of an ultimately successful campaign to engage a coalition of actors in the Netherlands, including the labour unions and the Dutch Ministry of Economic Affairs, with whom the board worked very closely together to thwart the bid. The public response provided to PPG’s bid makes reference to AkzoNobel’s top 10 position in the Dow Jones Sustainability Index, to its ranking in recognized indices including Sustainalytics and Bloomberg ESG, and to investments in the ‘Human Cities initiative’. The response stated ‘significant risks and uncertainties for thousands of jobs worldwide’, ‘significant cultural differences between both companies’, a failure by PPG ‘to sufficiently address significant stakeholder concerns, uncertainties and risks’ and a lack of ‘meaningful commitments or solutions customary in major transactions’.

We find the use of such stakeholder rhetoric as the basis for an expansion of economic protectionism problematic. In principle, we recognise the need for the development of broader conceptions of corporate purpose and for providing legal instruments to protect that purpose against the vagaries of an open takeover market. Such means include clear provisions on purpose and mission and/or the inclusion of stakeholder interests in the articles of association; the choice for a specific corporate form like a non-profit corporation; B-corp certification; specific share class structures and board structures; the explicit choice for a specific investor base and investing in investor relation and strengthening investor firewalls (Levillain et al., fc; Tsagas 2012; Veldman et al., 2016). However, we find that in order to make an appeal to provide protection on the basis of a commitment to a broader purpose and/or stakeholder interests, it is incumbent upon a board to adopt and embed these means in a timely manner. The timely adoption of these means, as well as the acceptance of the potential financial and reputational costs for corporations and shareholders, is crucial. Only on such conditions will such corporations provide a clear signal that the board and the shareholders are serious about adopting and defending such values.

The AkzoNobel board had neglected to fully adopt a legal defence that would help in the protection of a specific purpose, strategic timeframe or stakeholder interest ahead of the bid, and had similarly neglected to internalize the potential reputational and financial effects of such choices. Hence, invoking long-termism, stakeholder interests, and employee interests, rang rather hollow, and particularly so when the board has relied on such an agenda as an instrumental last-minute attempt to thwart a hostile takeover bid together with the Ministry for Economic Affairs.

Analysis: A special Takeover Regime?

A combination of economic nationalism and the strategic use of stakeholder rhetoric is problematic, because it provides a setting in which the stakeholder rhetoric is misused to apply takeover protections arbitrarily. This has the potential to disrupt the system of corporate governance in place; to impede the operation of takeover markets and capital markets; to create conditions for collusion among political and economic elites in national jurisdictions and to reflect badly on the use of stakeholder protections. The arbitrary use of such arguments and their contribution to the growth of economic nationalism leads us to develop another view on takeovers, based on a combination of mainstream and profit-with-purpose models of corporate governance.

Using a mainstream approach, we argue that corporations cannot claim protection from an open takeover market without clear cause. There is only a small category of corporations that, due to strategic and systemic risks of their operations, constitute valid objects for a special takeover regime. In the interest of a transparent takeover market, it must be made explicit which corporations these are, and how this special takeover regime affects the status of these corporations in ordinary markets. The stated adherence to broader conceptions of corporate purpose should not in themselves present a legitimate cause for exceptions to an ordinary takeover regime.

Beyond a mainstream approach, we argue that additional safeguards against an open market for corporate control can be considered for a specific category of corporations in which the board and shareholders have afforded significant and sustained effort to clearly and consistently develop a purpose, mission, and stakeholder strategy; in which appropriate legal means have been used to embed these strategic choices in a timely fashion; and in which the financial and reputational costs involved in these choices and their embedding have been accepted and internalized by all parties involved in the corporate governance process. Only if this process has been completed well before a takeover bid occurs can a defensive strategy along the lines of calling on broader stakeholders, including governments, be considered.

A combined mainstream and profit with purpose approach establishes clear categories for a comprehensive takeover regime, in which corporations are clearly differentiated according to their status as ordinary, systemic risk, or profit with purpose corporation. The development of this taxonomy provides a response to recent moves toward economic protectionism in the EU, furthers an agenda that respects fair competitive conditions between EU and foreign investors based on market rules, and provides incentives and means to corporations, boards and shareholders to think about the explicit legal embedding of their commitment to a broader purpose.

Georgina Tsagas is Assistant Professor in Corporate Law at the University of Bristol Law School.

Jeroen Veldman is a Senior Research Fellow at Cass Business School, City University

]]>Optimal Deterrence and the Preference Gap: Preference law doesn’t do what you think it doeshttps://www.law.ox.ac.uk/business-law-blog/blog/2018/03/optimal-deterrence-and-preference-gap-preference-law-doesnt-do-what-0
One of the most controversial legal issues arising in US corporate bankruptcy proceedings is the avoidance of preferential transfers. Defined simply, preference avoidance allows a debtor in bankruptcy to claw back payments made to a creditor in the few months before the bankruptcy filing, even when those payments were made on account of a valid outstanding debt. These recovered fundsMon, 12 Mar 2018 11:00:00 +0000Brook E. Gotberg18347 at https://www.law.ox.ac.ukOne of the most controversial legal issues arising in US corporate bankruptcy proceedings is the avoidance of preferential transfers. Defined simply, preference avoidance allows a debtor in bankruptcy to claw back payments made to a creditor in the few months before the bankruptcy filing, even when those payments were made on account of a valid outstanding debt. These recovered funds can then be redistributed to all creditors on a pro rata basis. Despite being a historical mainstay of bankruptcy proceedings, there remains disagreement over what preference law is intended to accomplish, and whether it is successful in accomplishing that goal.

A number of bankruptcy scholars have argued that preference law is about preserving the equality of distribution inherent in bankruptcy: all similarly situated creditors should be treated similarly. Accordingly, those creditors who were fortunate enough to be paid just before the bankruptcy should return the funds for equal distribution with others who were not so fortunate. Proponents of this view would find most legal exceptions to preference law, or efforts to distinguish between ‘good’ and ‘bad’ preferences, abhorrent.

Nonetheless, such distinctions do exist, and are justified by virtue of an alternative explanation for preference law: that it exists to deter creditors from engaging in ‘unusual collection efforts’ when the debtor is insolvent, as such efforts may push a struggling debtor into bankruptcy. Although scholars have previously raised serious objections to preference deterrence theory, this article is the first to test it against the theories established by Gary Becker (Crime and Punishment: An Economic Approach, 76 Pol. Econ. 169 (1968)) and Richard Posner (A Theory of Negligence, The Journal of Legal Studies 29, 32 (1972)) in the criminal and torts contexts, respectively.

The theory of deterrence established by Becker, and followed by Posner, is that a law can discourage actors from engaging in behaviour by creating an associated cost, so that rational actors will avoid the behaviour (and forego its benefits) in order to avoid the costs. The deterrent power of the law will depend primarily on the perceived likelihood of the cost being imposed and the perceived severity of the cost vis-à-vis the perceived benefit. The less the likelihood of punishment, the greater the need for severity (in order for the law to remain effective), and vice versa.

Under this theory, preference law is a profoundly weak example of deterrence, since preference avoidance only arises in situations where the debtor files for bankruptcy within 90 days of the targeted transfer, and even then, only when the debtor is inclined to pursue the transfer, as doing so is optional under the statute. Further, the penalty associated with obtaining a preference is, at worse, to return the amount of the preference, and in the vast majority of cases, debtors will agree to accept only a partial return – something like 50% – in order to avoid the costs of litigating the preference action.

Empirical evidence gleaned from interviews with debtors, creditors, and attorneys involved in recent Chapter 11 bankruptcy cases further demonstrates that preference law is uniformly ineffective as a deterrent. Creditors are advised by their attorneys to always accept (or even push for) payment from a debtor, since liability is unlikely to arise and, if it does, settlement is practically assured. Unrepresented creditors are largely unaware of preference law, or are confident in their ability to avoid liability by collecting early or arguing for an exception, such that preference law has relatively little impact on their ways of doing business.

Debtors typically will not bring a preference action against creditors they need to work with, and more sophisticated creditors are typically more able to predict bankruptcies and avoid preference liability by recovering early or fitting a transfer into one of the state exceptions. Accordingly, those creditors who are most impacted by preference law tend to be those who lack sufficient influence over the debtor to force or prevent a bankruptcy filing. To successfully deter actions that force a debtor into bankruptcy, preference law should be more focused on actors with the ability to influence a debtor’s decision to file for bankruptcy and should impose a greater penalty for such actions, so as to account for a low likelihood of punishment.

]]>Recent Developments in Bankruptcy Law, February 2018https://www.law.ox.ac.uk/business-law-blog/blog/2018/03/recent-developments-bankruptcy-law-february-2018
The bankruptcy courts and their appellate courts continue to explore issues of interest to practitioners and academics. This quarterly summary of recent developments in bankruptcy law covers cases reported during the fourth quarter of 2017.The Eleventh Circuit was particularly noteworthy, holding that an individual debtor may recover attorneys' fees for litigating a damages claim for a stay violation, including feesMon, 12 Mar 2018 05:30:00 +0000Jenner & Block18299 at https://www.law.ox.ac.ukThe bankruptcy courts and their appellate courts continue to explore issues of interest to practitioners and academics. This quarterly summary of recent developments in bankruptcy law covers cases reported during the fourth quarter of 2017.

The Eleventh Circuit was particularly noteworthy, holding that an individual debtor may recover attorneys' fees for litigating a damages claim for a stay violation, including fees on appeal (Mantiply v. Horne) and, perhaps more ominously, that a chapter 13 confirmation order is not binding on a creditor who does not object to confirmation but has filed a stay relief motion and that state forfeiture laws may remove property from the estate while the case is pending (Title Max v. Northington). A rehearing motion has been filed in the latter case.

The First Circuit has diverged from the Seventh Circuit, holding that rejection of a trademark license deprives the licensee of future use of the license. (Tempnology)

The Delaware bankruptcy court reaffirmed what should have been clear that a trustee's avoiding power and recovery claim is not limited to the amount of creditor claims, because section 550 speaks to benefit of the estate, not of creditors. (Physiotherapy Holdings)

Two bankruptcy courts have clarified the prerequisites for and the scope of third party releases and their jurisdiction to issue them, limiting releases by non-voting creditors and of non-indemnified insiders or professionals (New York: SunEdison) and prohibiting a 'purchase' of a release solely by making a contribution to the estate. (Colorado: Midway Gold)

The full memo, discussing these and other cases, is available here, and the full (900-page) compilation of all prior editions is available here.

]]>Machine Learning Funds and Investment Malpracticehttps://www.law.ox.ac.uk/business-law-blog/blog/2018/03/machine-learning-funds-and-investment-malpractice
As a consequence of recent advances in pattern recognition, big data and supercomputing, machine learning (ML) can today accomplish tasks that until recently only expert humans could perform. An area of particular interest is the management of investments, for several reasons. First, some of the most successful hedge funds in history happen to be algorithmic or process-driven. A key advantageFri, 09 Mar 2018 05:30:00 +0000Marcos López de Prado18322 at https://www.law.ox.ac.ukAs a consequence of recent advances in pattern recognition, big data and supercomputing, machine learning (ML) can today accomplish tasks that until recently only expert humans could perform. An area of particular interest is the management of investments, for several reasons. First, some of the most successful hedge funds in history happen to be algorithmic or process-driven. A key advantage of process-driven portfolio managers is that their decisions are objective and can be improved over time. A second advantage is that processes can be automated, leading to substantial economies of scale. A third advantage is that process-driven investments address the all-important concern of conflict of interests so pervasive among financial institutions.

The next wave of financial automation does not only involve following rules, but more importantly, making judgment calls (see this book for numerous examples). As emotional beings, subject to fears, hopes and agendas, humans are not particularly good at making fact-based decisions, particularly when those decisions involve conflicts of interest. In these situations, investors are better served when a machine makes the calls, based on facts learned from hard data. This not only applies to investment strategy development, but to virtually every area of financial advice: granting a loan, rating a bond, classifying a company, recruiting talent, predicting earnings, forecasting inflation, etc. Furthermore, machines will comply with the law, always, when programmed to do so. Customers' interests are protected by the same process across the entire clientele. If a dubious decision is made, investors can go back to the logs and understand exactly what happened. From a legal standpoint, it is much easier to improve an algorithmic investment process than one relying entirely on humans.

At the same time, algorithmic investments present their own set of legal challenges. In 'The 10 Reasons Most Machine Learning Funds Fail', I have identified some of the main reasons why most ML-based investments fail. Investors should be aware of the specific issues surrounding ML-driven investments, so that they can make informed decisions, and hold those investment managers accountable. In particular, ML investment managers may be liable for gross negligence or malpractice when they engage in practices that are known to be scientifically wrong or unethical.

For example, one of the most pervasive mistakes in financial research is to take some data, run it through an ML algorithm, backtest the predictions, and repeat the sequence until a nice-looking backtest shows up. Academic journals are filled with such pseudo-discoveries, and even large hedge funds constantly fall into this trap. It does not matter if the backtest is a walk-forward out-of-sample. The fact that we are repeating a test over and over on the same data will likely lead to a false discovery. This methodological error is so notorious among statisticians that they consider it scientific fraud, and the American Statistical Association warns against it in its ethical guidelines (American Statistical Association [2016], Discussion #4). It typically takes about 20 such iterations to discover a (false) investment strategy subject to the standard significance level (false positive rate) of 5%.

Although there are no laws specifically prohibiting backtest overfitting (yet), investors may have a legal case against this widespread investment malpractice that professional associations of mathematicians have deemed unethical. Such offenders are abusing the public trust earned by bona fide scientists. This is but one example of the reasons why ML funds fail to perform as advertised. As legal analysts and regulators learn more about these unethical or negligent practices, laws and regulations may be passed to finally curtail some of these abuses.

Dr. Marcos López de Prado is Research Fellow, Computational Research Division, Lawrence Berkeley National Laboratory, Berkeley, CA. The opinions expressed in this article are the author's and do not necessarily represent the views of the institutions and organizations he is affiliated with.